Course correction

The Indian economy is returning to normal after almost a year of unprecedented disruption. The focus should now shift to the sustainability of recovery and addressing pending policy shortcomings. One of the policy weaknesses India needs to urgently address is the underperformance of goods and services tax (GST), though it has improved in recent months. Sluggish overall revenue collection has exacerbated the fiscal stress and is affecting government expenditure. GST’s implementation with inadequate planning, a multiplicity of rates and their random tinkering, including for electoral reasons, and poor information technology support contributed to the problem.

The GST Council in its next meeting will reportedly address the issue of rate rationalisation to bring them closer to being revenue-neutral and simplify the indirect tax system. This would be a welcome step for a variety of reasons. For instance, as noted by the Fifteenth Finance Commission (FFC), GST collection net of compensation cess was at 5.1 per cent of gross domestic product (GDP) in 2019-20. The general government tax revenue subsumed under GST was estimated to be worth about 6.3 per cent of GDP in 2016-17. Lower revenue mobilisation needs to be addressed. According to a Reserve Bank of India September 2019 estimate, the effective weighted average GST rate declined to 11.6 per cent, compared to 14.4 per cent at the time of implementation. Since overall revenue collection has declined, the first objective should be to get back to the revenue-neutral rate. The FFC has suggested merging the 12 and 18 per cent slabs and have a three-rate structure.

The other objective should be to simplify the GST system, which will help improve ease of doing business. A multiplicity of rates, for instance, has also resulted in an inverted duty structure in many cases, which has affected revenues. Also, goods taxed at a higher rate need to be reviewed. For instance, taxes on cars beyond a certain size go up to 45-50 per cent. As a result, companies are creating capacity for smaller cars to fulfil domestic demand and are losing out on exports. Smaller cars contribute to a small fraction of global demand. This again underscores the case for rate rationalisation. Further, compliance has been an issue since the beginning. It is now being addressed with the spread of e-invoicing. Hopefully, things would improve in the coming months.

GST was expected to improve efficiency in the system and boost tax collection. But this has clearly not happened. Therefore, addressing all outstanding issues should be a top priority for both the Union and state governments. The FFC has suggested that the ambition in the medium term should be to attain GST revenue worth about 7 per cent of GDP. An increase of about 2 percentage points in revenue collection would help ease pressure on government finances  and boost developmental expenditure. India needs to improve its tax-GDP ratio, which is not only low compared to other emerging and advanced economies but has also remained stagnant over the years. Higher revenue mobilisation is particularly important at this stage as the debt-GDP is expected to expand to about 90 per cent. Addressing weaknesses in the GST system would be a good starting point.


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